What Expenses Qualify for the Minister’s Housing Allowance?

The minister’s housing allowance, established under Section 107 of the Internal Revenue Code, is a tax benefit for qualifying clergy. This provision allows ministers to exclude a portion of their compensation, designated as a housing allowance, from their gross income for federal income tax purposes. The allowance helps offset costs associated with providing a home and can be applied whether the minister rents, owns a home, or lives in a church-provided parsonage.

This financial arrangement is not a deduction but a direct exclusion from income, meaning the designated amount is not included in the wages reported for federal income tax calculations. The allowance is intended to cover expenses directly related to the minister’s residence.

Establishing the Housing Allowance

To benefit from the housing allowance, an individual must meet the IRS definition of a “minister of the gospel.” This requires being ordained, commissioned, or licensed by a recognized church or religious denomination. The individual must also be actively performing ministerial services, which can include conducting religious worship, administering sacraments, or having management responsibilities within the church. Employees of a church who do not perform these specific duties, such as administrative staff or custodians, are not eligible for this tax benefit.

The housing allowance must also be officially designated by the employing church or organization in advance, as this designation cannot be made retroactively. The church’s governing body must formally approve the specific dollar amount of the housing allowance before the calendar year in which it will be paid. This official action should be documented in writing, within an employment contract, the church budget, or the minutes of a board meeting.

Calculating the Maximum Exclusion

The amount a minister can exclude from income tax is not necessarily the full amount designated by the church. The excludable amount is determined by a three-part test, and the minister must use the lowest of three figures. This calculation is the responsibility of the individual minister. The first figure is the amount officially designated in advance by the church as the housing allowance.

The second figure is the actual amount the minister spends on qualifying housing expenses during the calendar year. The third figure is the fair rental value of the home, including furnishings and appurtenances like a garage, plus the cost of all utilities. Fair rental value is what the property would reasonably rent for on the open market, which can be determined by consulting local real estate professionals or comparing similar rental properties.

For example, if a church designates a $20,000 housing allowance, but the minister’s actual housing expenses are $18,000 and the home’s fair rental value is $22,000, the maximum exclusion is $18,000. This figure is the lowest of the three. The remaining $2,000 of the designated allowance must be reported as taxable income.

Qualifying Housing Expenses

A broad range of costs for providing and maintaining a home can be counted toward the “actual expenses” part of the exclusion calculation. The most common costs are mortgage payments, which include both principal and interest, or rent payments if the minister does not own their home. A down payment on the purchase of a primary residence is also a qualifying expense.

Beyond the primary payments for shelter, many other common household costs are eligible, including property taxes, homeowners’ insurance, and utilities. Qualifying utilities include:

• Electricity
• Gas
• Water
• Sewer
• Trash collection
• Basic local telephone service

Expenses for home upkeep, improvements, and furnishings also qualify, such as:

• Repairs and general maintenance, like pest control or snow removal
• Purchase and repair of furniture, appliances, and cookware
• Home improvements and remodeling
• Yard care and homeowners’ association dues

It is important to understand which expenses do not qualify. The allowance can only be used for a principal residence, so expenses related to a vacation home are not permitted. If a home equity loan is used for non-housing purposes, the payments are not eligible. The IRS also prohibits including payments for domestic help or the cost of:

• Food
• Paper products
• Personal toiletries
• Clothing

Record-Keeping and Tax Reporting

The minister is responsible for substantiating the housing expenses claimed, which requires record-keeping throughout the year. Ministers should retain all receipts, canceled checks, and bank or mortgage statements that document their qualifying housing costs. Having a dedicated bank account for household expenses can simplify this tracking process. These records are necessary to prove the “actual expenses” figure and would be required in an IRS audit.

Any portion of the designated housing allowance that exceeds the calculated maximum exclusion must be reported as taxable income on Form 1040. While the excluded housing allowance is exempt from federal income tax, it is not exempt from self-employment taxes under the Self-Employment Contributions Act (SECA).

A minister’s entire compensation, including salary and the full housing allowance, is subject to Social Security and Medicare taxes, and the minister must file Schedule SE to pay them. For tax reporting, the church should not include the excludable portion of the allowance in Box 1 of Form W-2. The church may report the designated amount in Box 14 of the W-2 for informational purposes.